ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
The following discussion of results of operations and financial condition includes periods prior to the acquisitions ofthe assets of Hadrian Manufacturing Inc., together with the stock of Hadrian Inc. (Hadrian Inc. and Hadrian Manufacturing Inc. are collectively referred to as "Hadrian"), the assets of Advance Technology Solutions, LLC (d/b/a ATS GREASEwatch) ("ATS GREASEwatch"), and the assets of Wade Drains ("Wade"), and the acquisition of Elkay in the Elkay merger. Our financial performance includes the Hadrian business subsequent to December 11, 2020, the ATS GREASEwatch business subsequent to April 16, 2021, the Wade business subsequent to November 17, 2021, and the Elkay business subsequent to July 1, 2022, the respective dates of their acquisitions. Accordingly, the discussion and analysis does not reflect any impact of Hadrian, ATS GREASEwatch, Wade, or Elkay transactions prior to the respective closing dates.
We completed the spin-off of our Process & Motion Control platform ("PMC") on October 4, 2021 in the Spin-Off Transaction, and, accordingly, the results of operations and financial condition associated with PMC have been reclassified to discontinued operations for all periods presented. As a result, the following discussion of results of operations and financial condition is centered on the Zurn business excluding PMC. The consolidated statements of cash flows for the year ended December 31, 2022, the year ended December 31, 2021, and the nine-month Transition Period ended December 31, 2020 have not been adjusted to separately disclose cash flows related to the discontinued operations. See Item 8, Note 4, Discontinued Operations for additional information on cash flows associated with the discontinued operations.
You should read the following discussion of our financial condition and results of operations together with Item 8, Financial Statements and Supplementary Data. Following the end of our fiscal year ended March 31, 2020, we transitioned to a December 31 fiscal year-end. The nine-month period from April 1, 2020, to December 31, 2020 is referred to as the Transition Period. Fiscal years prior to and including fiscal year 2020 ended on March 31 of each calendar year.
This discussion contains forward-looking statements and involves numerous risks and uncertainties, including, but not limited to, those described in the "Risk Factors" in Item 1A of this report. Actual results may differ materially from those contained in any forward-looking statements. See also "Cautionary Notice Regarding Forward-Looking Statements" found elsewhere in this report.
The information contained in this section is provided as a supplement to the consolidated financial statements and the related notes included elsewhere in this report to help provide an understanding of our financial condition, changes in our financial condition and results of our operations. This section is organized as follows:
Company Overview. This section provides a general description of our business.
Financial Statement Presentation. This section provides a brief description of certain items and accounting policies that appear in our financial statements and general factors that impact these items.
Critical Accounting Estimates. This section discusses the accounting policies and estimates that we consider to be important to our financial condition and results of operations and that require significant judgment and estimates by management in their application.
Recent Accounting Pronouncements. This section cites to the discussion of new or revised accounting pronouncements and standards in Item 8, Note 2, Significant Accounting Policies of our consolidated financial statements.
Overview of Recent Developments. This section provides a description of the recent events impacting our results of operations.
Results of Operations. This section provides an analysis of our results of operations. As noted above, following the end of fiscal 2020, we transitioned to a December 31 fiscal year-end and accordingly we reported the nine-month period from April 1, 2020, to December 31, 2020 as a Transition Period. In providing analysis of the results of our operations, we have provided a comparison of our year ended December 31, 2022 to the year ended December 31, 2021, along with a comparison of the year ended December 31, 2021 to the year ended December 31, 2020.
Non-GAAP Financial Measures. This section provides an explanation of certain financial measures we use that are not in accordance with U.S. generally accepted accounting principles ("GAAP").
Covenant Compliance. This section provides a discussion of certain restrictive covenants in our credit agreement.
Liquidity and Capital Resources. This section provides an analysis of our cash flows and year-to-year comparisons for our years ended December 31, 2022, 2021, and 2020, as well as a discussion of our indebtedness and its potential effects on our liquidity.
Tabular Disclosure of Contractual Obligations. This section provides a discussion of our commitments as of December 31, 2022.
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Quantitative and Qualitative Disclosures about Market Risk. This section discusses our exposure to potential losses arising from adverse changes in interest rates and foreign exchange rates.
Company Overview
We are a growth-oriented, pure-play water management business that designs, procures, manufactures, and markets what we believe is the broadest sustainable product portfolio of specification-driven water management solutions to improve health, human safety and the environment. Our product portfolio includes professional grade water safety and control products, flow system products, hygienic and environmental products, and drinking water products for public and private spaces that deliver superior value to building owners, positively impact the environment and human hygiene and reduce product installation time. Zurn Elkay's heritage of innovation and specification has allowed us to provide highly-engineered, mission-critical solutions to customers for decades and affords us the privilege of having long-term, valued relationships with market leaders. We operate in a disciplined way and the Zurn Elkay Business System (“ZEBS”) is our operating philosophy. Grounded in the spirit of continuous improvement, ZEBS creates a scalable, process-based framework that focuses on driving superior customer satisfaction and financial results by targeting world-class operating performance throughout all aspects of our business.
Refer to Item 1, Business for additional information.
Financial Statement Presentation
The following paragraphs provide a brief description of certain items and accounting policies that appear in our financial statements and general factors that impact these items.
Net sales. Net sales represent gross sales less deductions taken for sales returns and allowances and incentive rebate programs.
Cost of sales. Cost of sales includes all costs of manufacturing required to bring a product to a ready for sale condition. Such costs include direct and indirect materials, direct and indirect labor costs, including fringe benefits, supplies, utilities, depreciation, freight and shipping, insurance, pension and postretirement benefits, information technology costs and other manufacturing related costs.
The largest component of our cost of sales is cost of materials, which represented approximately 35% of net sales in the year ended December 31, 2022. We purchase a broad range of materials and components throughout the world in connection with our manufacturing activities. Major raw materials and components include brass, castings, copper, zinc, forgings, plate steel, high-performance engineered plastic and resin. We have a strategic sourcing program that is designed to significantly reduce the number of direct and indirect suppliers we use and to lower the cost of purchased materials.
Selling, general and administrative expenses. Selling, general and administrative expenses primarily includes sales and marketing, finance and administration, engineering and technical services and warehousing. Our major cost elements include salary and wages, fringe benefits, insurance, depreciation, advertising, travel and information technology costs.
Critical Accounting Estimates
The methods, estimates and judgments we use in applying our critical accounting policies have a significant impact on the results we report in our consolidated financial statements. We evaluate our estimates and judgments on an on-going basis. We base our estimates on historical experience and on assumptions that we believe to be reasonable under the circumstances. Our experience and assumptions form the basis for our judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may vary from what we anticipate and different assumptions or estimates about the future could change our reported results. Within the context of these critical accounting policies, we are not currently aware of any reasonably likely event that would result in materially different amounts being reported.
We believe the following accounting policies are the most critical to us in that they are important to our financial statements and they require difficult, subjective and/or complex judgments in the preparation of our consolidated financial statements. For additional information, see Item 8, Note 2, Significant Accounting Policies, to our consolidated financial statements.
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Revenue recognition. Under Accounting Standards Codification ("ASC") 606, Revenue from Contracts with Customers ("ASC 606"), a performance obligation is a promise in a contract to transfer a distinct good or service to the customer, and is the unit of account. A contract’s transaction price is allocated to each distinct performance obligation and revenue is recognized when obligations under the terms of a contract with the customer are satisfied. For our product sales, revenue is recognized at a point-in-time when control of the product is transferred to the customer, which generally occurs when the product is shipped from our manufacturing facility to the customer. When contracts include multiple products to be delivered to the customer, generally each product is separately priced and is determined to be distinct within the context of the contract. Other than a standard assurance-type warranty that the product will conform to agreed-upon specifications, there are generally no other significant post-shipment obligations. The expected costs associated with standard warranties is recognized as an expense when the products are sold.
When the contract provides the customer the right to return eligible products or when the customer is part of a sales rebate program, we reduce revenue at the point of sale using current facts and historical experience by using an estimate for expected product returns and rebates associated with the transaction. These estimates are adjusted at the earlier of when the most likely amount of consideration that is expected to be received changes or when the consideration becomes fixed. Accordingly, an increase or decrease to revenue is recognized at that time.
Sales and other taxes collected concurrent with revenue-producing activities are excluded from revenue. We have elected to recognize the cost for freight and shipping when control of products has transferred to the customer as a component of cost of sales in the consolidated statements of operations. We classify shipping and handling fees billed to our customers as net sales and the corresponding costs are classified as cost of sales in the consolidated statements of operations.
Receivables. Receivables are stated net of allowances for doubtful accounts of $1.4 million at December 31, 2022 and $1.2 million at December 31, 2021. We assesses the collectability of customer receivables based on the credit worthiness of a customer as determined by credit checks and analysis, as well as the customer’s payment history. In determining the allowance for doubtful accounts, we also consider various factors including the aging of customer accounts and historical write-offs. In addition, we monitor other risk factors, including forward-looking information when establishing adequate allowances for doubtful accounts, which reflects the current estimate of credit losses expected to be incurred over the life of the receivables. Generally, advance payment is not required. Allowances for doubtful accounts established are recorded within selling, general and administrative expenses within the consolidated statements of operations.
Inventory. Inventories are stated at the lower of cost or market. Market is determined based on estimated net realizable values. Approximately 89% and 84% of our total inventories as of December 31, 2022 and December 31, 2021, respectively, were valued using the "last-in, first-out" (LIFO) method. All remaining inventories are valued using the "first-in, first-out" (FIFO) method.
In some cases we have determined a certain portion of our inventories are excess or obsolete. In those cases we write down the value of those inventories to their net realizable value based upon assumptions about future demand and market conditions. If actual market conditions are less favorable than those projected by management, additional inventory write-downs may be required. The total write-down of inventories charged to expense was $0.8 million, $0.9 million and $1.5 million, during the year ended December 31, 2022, the year ended December 31, 2021, and the nine-month Transition Period ended December 31, 2020, respectively.
Purchase accounting and business combinations. Assets acquired and the liabilities assumed as part of a business combination are recognized separately from goodwill at their acquisition date fair values. Goodwill as of the acquisition date is measured as the excess of consideration transferred over the net of the acquisition date fair values of the assets acquired and the liabilities assumed. We review and consider input from outside specialists, if and when appropriate to develop discount rates, and use estimates and assumptions about the future performance of the business to accurately value assets acquired and liabilities assumed at the acquisition date. We may refine these estimates during the measurement period, which may be up to one year from the acquisition date. As a result, during the measurement period, we record adjustments to the assets acquired and liabilities assumed with the corresponding offset recorded to goodwill. Upon the conclusion of the measurement period or final determination of the values of the assets acquired or liabilities assumed, whichever comes first, any subsequent adjustments are recorded in our consolidated statements of operations.
Impairment of intangible assets and tangible fixed assets. The carrying value of long-lived assets, including amortizable intangible assets and tangible fixed assets, are evaluated for impairment whenever events or changes in circumstances indicate that the related carrying amounts may not be recoverable. Impairment of amortizable intangible assets and tangible fixed assets is generally determined by comparing projected undiscounted cash flows to be generated by the asset, or group of assets, to its carrying value. If impairment is identified, a loss is recorded equal to the excess of the asset's net book value over its fair value, and the cost basis is adjusted. Determination of the fair value requires various estimates including internal cash flow estimates generated from the asset, quoted market prices and appraisals as appropriate to determine fair
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value. Actual results could vary from these estimates. During the year ended December 31, 2022, the year ended December 31, 2021, and the nine-month Transition Period ended December 31, 2020, no impairment losses were recognized.
Goodwill, trademarks and certain tradenames have indefinite lives and are not amortized. However, the goodwill and intangible assets are tested annually for impairment, and may be tested more frequently if any triggering events occur that would reduce the recoverability of the asset. In conducting the annual impairment test for goodwill, we have the option to first assess qualitative factors to determine whether it is more likely than not (> 50% likelihood) the fair value of any reporting unit is less than its carrying amount. If a qualitative assessment determines an impairment is more likely than not, we are required to perform a quantitative impairment test. Otherwise, no further analysis is required. Alternatively, we may elect to proceed directly to the quantitative impairment test. In conducting a qualitative assessment, we use a discounted cash flow methodology based on future business projections and a market value approach (guideline public company comparables). We perform our goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. If the carrying amount exceeds the fair value of the reporting unit, an impairment charge is recognized for the amount by which the carrying amount exceeds the reporting unit's fair value up to the amount of the recorded goodwill.
During the fourth quarter of the year ended December 31, 2022, we completed our annual goodwill impairment test and elected to perform a qualitative assessment. No goodwill impairment charges were recorded during the year ended December 31, 2022, the year ended December 31, 2021, or the nine-month Transition Period ended December 31, 2020.
Retirement benefits. We have significant pension and post-retirement benefit income and expense and assets/liabilities that are developed from actuarial valuations. These valuations include key assumptions regarding discount rates, expected return on plan assets, mortality rates and the current health care cost trend rate. We consider current market conditions in selecting these assumptions. Changes in the related pension and post-retirement benefit income/costs or assets/liabilities may occur in the future due to changes in the assumptions and changes in asset values.
We recognize the net actuarial gains or losses in excess of unrecognized gain or loss exceeding 10 percent of the greater of the market-related value of plan assets or the plan's projected benefit obligation at re-measurement (the "corridor") in our consolidated statements of operations during the fourth quarter of each fiscal year (or upon any re-measurement date). During the year ended December 31, 2022, the year ended December 31, 2021, and the nine-month Transition Period ended December 31, 2020, we recognized non-cash actuarial gain (loss) from continuing operations of $1.9 million, $1.2 million, and $(0.3) million, respectively, in connection with re-measurements of our plans. Net periodic benefit costs recorded on a quarterly basis are primarily comprised of service and interest cost, amortization of unrecognized prior service cost and the expected return on plan assets. See Item 8, Note 16, Retirement Benefits for additional information.
The obligation for postretirement benefits other than pension also is actuarially determined and is affected by assumptions including the discount rate and expected future increase in per capita costs of covered postretirement health care benefits. Changes in the discount rate and differences between actual and assumed per capita health care costs may affect the recorded amount of the expense in future periods.
Income taxes. We are subject to income taxes in the United States and numerous foreign jurisdictions. Significant judgment is required in determining our worldwide provision for income taxes and recording the related deferred tax assets and liabilities.
We assess our income tax positions and record tax liabilities for all years subject to examination based upon management’s evaluation of the facts and circumstances and information available at the reporting dates. For those income tax positions where it is more-likely-than-not, based on technical merits, that a tax benefit will be sustained upon the conclusion of an examination, we have recorded the largest amount of tax benefit having a cumulatively greater than 50% likelihood of being realized upon ultimate settlement with the applicable taxing authority, assuming that it has full knowledge of all relevant information. For those tax positions which do not meet the more-likely-than-not threshold regarding the ultimate realization of the related tax benefit, no tax benefit has been recorded in the financial statements. In addition, we provide for interest and penalties, as applicable, and record such amounts as a component of the overall income tax provision. As of December 31, 2022 and 2021, our liability for unrecognized tax benefits was $5.5 million and $5.9 million, respectively.
We recognize deferred tax assets and liabilities based on the differences between the financial statement carrying amounts and the tax bases of assets and liabilities, net operating losses (“NOL’s”), tax credit and other carryforwards. We regularly review our deferred tax assets for recoverability and establish a valuation allowance based on historical losses, projected future taxable income and the expected timing of the reversals of existing temporary differences. As a result of this review, we established a full valuation allowance against U.S. federal and state capital loss carryforwards, as well as certain state tax credit carryforwards, and continue to maintain a partial valuation allowance against certain foreign NOL carryforwards and other related deferred tax assets, as well as certain U.S. state NOL carryforwards. As of December 31, 2022 and 2021, valuation allowances of $32.2 million and $35.1 million, respectively, were recorded against our deferred tax assets. See Item 8 Note 17, Income Taxes for additional information.
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Commitments and Contingencies. We are subject to proceedings, lawsuits and other claims related to environmental, labor, product and other matters. We are required to assess the likelihood of any adverse judgments or outcomes to these matters as well as potential ranges of probable losses. We determine the amount of accruals needed, if any, for each individual issue based on our professional knowledge and experience and discussions with legal counsel. The required accruals may change in the future due to new developments in each matter, the ultimate resolution of each matter or changes in approach, such as change in strategy.
Accruals are recorded on our consolidated balance sheets to reflect our contractual liabilities relating to warranty commitments to our customers. We provide warranty coverage at various lengths and terms to our customers depending on standard offerings and negotiated contractual agreements. We accrue an estimate for warranty expense at the time of sale based on historical warranty return rates and repair costs. Should future warranty experience differ materially from our historical experience, we may be required to record additional warranty accruals which could have a material adverse effect on our results of operations in the period in which these additional accruals are required.
As noted in Item 8, Note 18, Commitments and Contingencies, certain subsidiaries are subject to asbestos litigation. As a result, we have recorded a liability for pending and potential future asbestos claims, as well as a receivable for insurance coverage of such liability. The valuation of our potential asbestos liability was developed from actuarial studies based on the number and severity of future asbestos claims, future settlement costs, and the effectiveness of defense strategies and settlement initiatives. There are inherent uncertainties involved in estimating the number of future asbestos claims, future settlement costs, and the effectiveness of defense strategies and settlement initiatives.As a result, actual liability could differ from the estimate described herein and could be substantial.
Our receivable for insurance coverage was developed by considering our experience in asbestos litigation, the insurance payments made to date by our insurance carriers, existing insurance policies, the industry ratings of the insurers and the advice of insurance coverage counsel with respect to applicable insurance coverage law relating to the terms and conditions of those policies. As of December 31, 2022, the receivable recorded corresponds to the amount of this potential asbestos liability that we believe is probable to be covered by available insurance. However, there is no assurance our current insurance coverage will ultimately be available or that this asbestos liability will not ultimately exceed our coverage limits. Factors that could cause a decrease in the amount of available coverage or create gaps in coverage include: changes in law governing the policies, potential disputes and settlements with the carriers regarding the scope of coverage, and insolvencies of one or more of our carriers.
Recent Accounting Pronouncements
See Item 8, Note 2, Significant Accounting Policies regarding recent accounting pronouncements.
Overview of Recent Developments
Elkay Merger
On July 1, 2022, we completed the Elkay Merger for a preliminary purchase price of $1,462.9 million. Elkay, a market leader of drinking water solutions and commercial sinks, complements our existing product portfolio. The preliminary purchase price includes $1,417.0 million of our common stock based on the closing stock price of $27.48 on July 1, 2022, and $45.9 million of net cash payments for the repayment of Elkay's term loan and Elkay's transaction related costs outstanding that were in excess of Elkay's cash and cash equivalents at the time of closing. Pursuant to the Merger Agreement, we issued 51,564,524 shares of our common stock, which represented approximately 29% of our outstanding common shares immediately following the Merger. The total number of shares of our common stock issued at closing was preliminary and subject to change upon finalization of customary post-closing adjustments with respect to cash, indebtedness and working capital. We expect that approximately 186,000 of these shares will be returned to us in the first half of calendar year 2023 as a result of lower working capital and cash balances at closing compared to targets stipulated in the Merger Agreement. We incurred transaction-related costs of approximately $33.7 million for the year ended December 31, 2022. These costs were associated with legal and professional services and were recognized as selling, general and administrative expenses in our consolidated statements of operations.
See Item 8, Note 3, Acquisitions for more information.
Discontinued Operations
During the year ended December 31, 2021, we completed the spin-off of our PMC platform. The operating results of PMC are reported as discontinued operations in our consolidated statements of operations for all periods presented, as the Spin-Off Transaction represented a strategic shift that had a major impact on our operations and financial results. During the year ended December 31, 2022, we received $35.0 million from Regal Rexnord Corporation as a result of the final working capital and cash balances at closing exceeding the targets stipulated in the Spin-Off Transaction agreement.
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The major components of the Income from discontinued operations, net of tax presented in the consolidated statements of operations during the year ended December 31, 2022, the year ended December 31, 2021, and the nine-month Transition Period ended December 31, 2020 are included in the table below (in millions):
Year Ended (1) Year Ended (2) Nine-Month Transition Period Ended
Selling, general and administrative expenses (2.9) 260.2 168.0
Restructuring and other similar charges — 1.9 12.9
Amortization of intangible assets — 9.9 10.1
Interest expense, net — 4.1 3.3
Actuarial loss on pension and postretirement benefit obligations — 4.8 1.3
Other non-operating income, net — (5.6) (6.4)
Income from discontinued operations before income tax 2.9 99.1 109.2
Income tax (provision) benefit 1.8 (28.0) (25.8)
Equity method investment income — 0.3 0.2
Non-controlling interest income — (0.2) (0.4)
Income from discontinued operations, net of tax $ 4.7 $ 71.2 $ 83.2
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(1)Results of operations for the year ended December 31, 2022 includes the reversal of certain accruals as a result of costs we are obligated to indemnify Regal Rexnord Corporation for being lower than original estimates.
(2)Results of operations during the year ended December 31, 2021 reflect the period from January 1, 2021 through October 4, 2021, the date on which the Spin-Off Transaction of PMC was completed.
During the fiscal year ended March 31, 2019, we completed the sale of our VAG business, which was previously included in our Water Management platform. The sale agreement provided for contingent consideration based on Earn-out EBITDA, as defined in the sale agreement. During the year ended December 31, 2021, we received a $4.2 million cash payment as a result of the VAG business performance in its fiscal year ended March 31, 2021, which represented the final period of the earn-out, which was recorded in income from discontinued operations, net of tax in our condensed consolidated statements of operations.
See Item 8, Note 4, Discontinued Operations for more information.
Restructuring and Other Similar Costs
During the year ended December 31, 2022, we continued to execute various restructuring actions. These initiatives were intended to drive efficiencies and reduce operating costs while also modifying our footprint to reflect changes in the markets we serve, the impact of acquisitions on our overall manufacturing capacity and the refinement of our overall product portfolio. These restructuring actions primarily resulted in workforce reductions, lease termination costs, and other facility rationalization costs. We expect to continue executing similar initiatives to optimize our operating margin and manufacturing footprint. As such, we expect further expenses related to workforce reductions, potential impairment of assets, lease termination costs, and other facility rationalization costs.
We recorded restructuring charges of $15.4 million, $3.7 million and $1.7 million for the year ended December 31, 2022, the year ended December 31, 2021, and the nine-month Transition Period ended December 31, 2020, respectively. See Item 8, Note 5, Restructuring and Other Similar Costs for more information.
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Results of Operations
Year Ended December 31, 2022 Compared with the Year Ended December 31, 2021
Net sales
(Dollars in Millions)
Year Ended
Net sales were $1,281.8 million for the year ended December 31, 2022, a 40.7% increase year over year. Excluding a 31% increase in sales associated with the Elkay merger and prior year acquisition of Wade and a 1% decrease in sales associated with foreign currency translation, core sales increased 11% year over year as nearly all of our product categories contributed to the sales growth.
Income from operations
(Dollars in Millions)
Year Ended
Income from operations was $107.1 million for the year ended December 31, 2022, or 8.4% of net sales, compared to income from operations of $107.0 million, or 11.7% of net sales for the year ended December 31, 2021. The year over year change is primarily the result of transaction costs related to the Elkay merger, higher intangible asset and other acquisition related amortization, depreciation, and restructuring costs following our merger with Elkay as well as higher year-over-year costs within transportation and material inputs. These costs were partially offset by the favorable impact of year-over-year sales growth (inclusive of price increases), productivity savings, and lower non-cash stock-based compensation expense.
Interest expense, net
Interest expense, net was $26.9 million for the year ended December 31, 2022 compared to $34.7 million for the year ended December 31, 2021, primarily due to lower outstanding borrowings following the Spin-Off Transaction refinancing, partially offset by higher year over year interest rates. See Item 8, Note 11 Long-Term Debt for more information.
Loss on extinguishment of debt
There was no loss on the extinguishment of debt recognized for the year ended December 31, 2022. During the year ended December 31, 2021, we recognized a $20.4 million loss on the extinguishment of debt in connection with the refinancing of our debt in connection with the Spin-Off Transaction. The loss on extinguishment of debt was comprised of $16.2 million of refinancing related costs, as well as a non-cash write-off of unamortized debt issuance costs associated with the previously outstanding debt of $4.2 million. See Item 8, Note 11 Long-Term Debt for more information.
Actuarial gain on pension and postretirement benefit obligations
Actuarial gain on pension and postretirement benefit obligations for the year ended December 31, 2022, was $1.9 million compared to a gain of $1.2 million for the year ended December 31, 2021. The non-cash actuarial gain recognized for the year ended December 31, 2022, was primarily due to a year over year increase in discount rates assumptions utilized in performing the annual remeasurement of our defined benefit plans, partially offset by unfavorable asset performance. The non-cash actuarial gain recognized for the year ended December 31, 2021, was primarily due to a year over year increase in the discount rate assumptions utilized within the annual remeasurement of our defined benefit plans. See Item 8, Note 16 Retirement Benefits for more information.
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Other income (expense), net
Other income, net for the year ended December 31, 2022, was $1.7 million compared to other expense, net of $0.7 million for the year ended December 31, 2021. Other income (expense), net consists primarily of gains and losses from foreign currency transactions, the non-service cost components of net periodic benefit costs associated with our defined benefit plans, and other non-operational gains and losses. The year-over-year change is primarily driven by income recognized in the year ended December 31, 2022 in connection with an insurance settlement, partially offset by a charge recognized for the amount by which our estimated asbestos exposures exceed our estimated insurance coverage available.
Provision for income taxes
The income tax provision for the year ended December 31, 2022 was $26.8 million, or an effective tax rate of 32.0%. The effective income tax rate for the year ended December 31, 2022 was above the U.S. federal statutory rate of 21% primarily due to non-deductible acquisition costs associated with the Merger, the accrual of foreign income taxes, which are generally above the U.S. federal statutory rate, the accrual of additional income taxes associated with compensation deduction limitations under Section 162(m) of the Internal Revenue Code and the accrual of various state income taxes, partially offset by the recognition of income tax benefits associated with share-based payments and the reduction in the valuation allowance associated with certain state NOL carryforwards. The income tax provision for the year ended December 31, 2021 was $2.7 million, or an effective tax rate of 5.2%. The effective income tax rate for the year ended December 31, 2021 was below the U.S. federal statutory rate of 21% primarily due to the recognition of income tax benefits associated with share-based payments, slightly offset by the accrual of foreign income taxes, which are generally above the U.S. federal statutory rate, the accrual of additional income taxes associated with compensation deduction limitations under Section 162(m) of the Internal Revenue Code, the increase in the valuation allowance associated with certain state NOL carryforwards, the accrual of unrecognized income tax benefits in which such realization is not deemed more-likely-than-not and the accrual of various state income taxes.
Net income from continuing operations
Our net income from continuing operations for the year ended December 31, 2022, was $57.0 million, compared to net income from continuing operations of $49.7 million for the year ended December 31, 2021, as a result of the factors described above. Diluted net income per share from continuing operations was $0.37 for the year ended December 31, 2022, as compared to $0.40 per share for the year ended December 31, 2021.
Net income
Net income for the year ended December 31, 2022, was $61.7 million compared to $120.9 million for the year ended December 31, 2021. Diluted net income per share was $0.40 for the year ended December 31, 2022, compared to $0.97 for the year ended December 31, 2021. Income from discontinued operations, net of tax, was $4.7 million for the year ended December 31, 2022 compared to $71.2 million for the year ended December 31, 2021. The year-over-year change in net income from discontinued operations, net of tax, is due to the completion of the PMC Spin-Off Transaction in the year ending December 31, 2021. The year-over-year change in net income is primarily the result of the factors described above.
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Year Ended December 31, 2021 Compared with the Year Ended December 31, 2020
Net sales
(Dollars in Millions)
Year Ended
Net sales were $910.9 million for the year ended December 31, 2021, a 22.1% increase year over year. Excluding a 1% increase to net sales associated with foreign currency translation and an 8% increase in net sales resulting from our 2020 acquisition of Hadrian and the 2021 acquisition of Wade, core net sales increased 13% year over year. The increase in core net sales was driven by increased demand across the majority of our product categories.
Income from operations
(Dollars in Millions)
Year Ended
Income from operations was $107.0 million for the year ended December 31, 2021, or 11.7% of net sales, compared to income from operations of $107.7 million, or 14.4% of net sales, for the year ended December 31, 2020. Income from operations as a percentage of net sales decreased 270 basis points year-over-year as the favorable impact of increased sales was more than offset by the change in the adjustment to state inventories at last-in-first-out cost, higher non-cash stock-based compensation expense, the mix impact of the Hadrian acquisition and the benefit of temporary cost reduction actions in the prior year in response to the COVID-19 pandemic.
Interest expense, net
Interest expense, net was $34.7 million during the year ended December 31, 2021 compared to $45.9 million during the year ended December 31, 2020, primarily due to lower outstanding borrowings following the Spin-Off Transaction refinancing. See Item 8, Note 11 Long-Term Debt for more information.
Loss on extinguishment of debt
During the year ended December 31, 2021, we recognized a $20.4 million loss on the extinguishment of debt in connection with the refinancing of our debt in connection with the Spin-Off Transaction. The loss on extinguishment of debt was comprised of $16.2 million of refinancing related costs, as well as a non-cash write-off of unamortized debt issuance costs associated with the previously outstanding debt of $4.2 million. See Item 8, Note 11 Long-Term Debt for more information. There was no loss on the extinguishment of debt recognized during the year ended December 31, 2020.
Actuarial gain (loss) on pension and postretirement benefit obligations
Actuarial gain on pension and postretirement benefit obligations for the year ended December 31, 2021, was $1.2 million compared to a loss of $21.2 million for the year ended December 31, 2020. The non-cash actuarial gain recognized for the year ended December 31, 2021, was primarily due to a year over year increase in discount rates assumptions utilized in performing the annual remeasurement of our defined benefit plans. The non-cash actuarial loss recognized for the year ended December 31, 2020, was primarily due to favorable asset performance and contributions made to the plan partially offset by decreases in the year over year discount rate assumptions utilized within the annual remeasurement of our defined benefit plans. See Item 8, Note 16 Retirement Benefits for more information.
Other expense, net
Other expense, net for the year ended December 31, 2021, was $0.7 million compared to other expense, net of $2.5 million for the year ended December 31, 2020. Other expense, net consists primarily of gains and losses from foreign currency transactions, the non-service cost components of net periodic benefit costs associated with our defined benefit plans and other non-operational gains and losses. The year-over-year change is primarily driven by changes in foreign currency rates and lower interest cost within the non-service cost components of our defined benefit plans.
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Provision for income taxes
The income tax provision for the year ended December 31, 2021 was $2.7 million, or an effective tax rate of 5.2%. The effective income tax rate for the year ended December 31, 2021 was below the U.S. federal statutory rate of 21% primarily due to the recognition of income tax benefits associated with share-based payments slightly offset by the accrual of foreign income taxes, which are generally above the U.S. federal statutory rate, the accrual of additional income taxes associated with compensation deduction limitations under Section 162(m) of the Internal Revenue Code, the increase in the valuation allowance associated with certain state NOL carryforwards, the accrual of unrecognized income tax benefits in which such realization is not deemed more-likely-than-not and the accrual of various state income taxes. The income tax provision for the year ended December 31, 2020 was $9.5 million, or an effective tax rate of 24.9%. The effective income tax rate for the year ended December 31, 2020 was above the U.S. federal statutory rate of 21% primarily due to the accrual of foreign income taxes, which are generally above the U.S. federal statutory rate, the accrual of additional income taxes associated with compensation deduction limitations under Section 162(m) of the Internal Revenue Code and the accrual of various state income taxes, partially offset by the recognition of income tax benefits associated with share-based payments.
Net income from continuing operations
Our net income from continuing operations for the year ended December 31, 2021, was $49.7 million, compared to net income from continuing operations of $28.6 million for the year ended December 31, 2020, as a result of the factors described above. Diluted net income per share from continuing operations was $0.40 for the year ended December 31, 2021, as compared to $0.23 per share for the year ended December 31, 2020.
Net income
Net income for the year ended December 31, 2021, was $120.9 million compared to $146.7 million for the year ended December 31, 2020. Diluted net income per share was $0.97 for the year ended December 31, 2021, compared to $1.19 for the year ended December 31, 2020. Income from discontinued operations, net of tax, was $71.2 million for the year ended December 31, 2021 compared to $118.1 million for the year ended December 31, 2020. The year-over-year change in net income from discontinued operations, net of tax, is due to the PMC results for the year ended December 31, 2021 only representing activity through the Spin-Off Transaction date and the recognition of approximately $60.0 million in costs associated with completing the Spin-Off Transaction. The year-over-year change in net income is primarily the result of the factors described above.
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Non-GAAP Financial Measures
Non-GAAP financial measures are intended to supplement and not replace financial measures prepared in accordance with GAAP.
Core sales
Core sales excludes the impact of acquisitions (such as the Elkay and Wade Drains acquisitions), divestitures (such as PMC) and foreign currency translation. Management believes that core sales facilitates easier and more meaningful comparisons of our net sales performance with prior and future periods and to our peers. We exclude the effect of acquisitions and divestitures because the nature, size and number of acquisitions and divestitures can vary dramatically from period to period and between us and our peers, and can also obscure underlying business trends and make comparisons of long-term performance difficult. We exclude the effect of foreign currency translation from this measure because the volatility of currency translation is not under management's control.
EBITDA
EBITDA represents earnings before interest and other debt related activities, taxes, depreciation and amortization. EBITDA is presented because it is an important supplemental measure of performance and it is frequently used by analysts, investors and other interested parties in the evaluation of companies in our industry. EBITDA is also presented and compared by analysts and investors in evaluating our ability to meet debt service obligations. Other companies in our industry may calculate EBITDA differently. EBITDA is not a measurement of financial performance under U.S. GAAP and should not be considered as an alternative to cash flow from operating activities or as a measure of liquidity or an alternative to net income as indicators of operating performance or any other measures of performance derived in accordance with U.S. GAAP. Because EBITDA is calculated before recurring cash charges, including interest expense and taxes, and is not adjusted for capital expenditures or other recurring cash requirements of the business, it should not be considered as a measure of discretionary cash available to invest in the growth of the business.
Adjusted EBITDA
Adjusted EBITDA (as described below in "Covenant Compliance") is an important measure because, under our credit agreement, our ability to incur certain types of acquisition debt and certain types of subordinated debt, make certain types of acquisitions or asset exchanges, operate our business and make dividends or other distributions, all of which will impact our financial performance, is impacted by our Adjusted EBITDA, as our lenders measure our performance with a net first lien leverage ratio by comparing our senior secured bank indebtedness to our Adjusted EBITDA (see "Covenant Compliance" for additional discussion of this ratio, including a reconciliation to our net income). We reported net income in the year ended December 31, 2022, of $61.7 million and Adjusted EBITDA for the same period of $264.6 million. See "Covenant Compliance" for a reconciliation of Adjusted EBITDA to GAAP net income.
Covenant Compliance
Our credit agreement, which governs our senior secured credit facilities, contains, among other provisions, restrictive covenants regarding indebtedness, payments and distributions, mergers and acquisitions, asset sales, affiliate transactions, capital expenditures and the maintenance of certain financial ratios. Payment of borrowings under the credit agreement may be accelerated if there is an event of default. Events of default include the failure to pay principal and interest when due, a material breach of a representation or warranty, certain non-payments or defaults under other indebtedness, covenant defaults, events of bankruptcy and a change of control. Certain covenants contained in the credit agreement restrict our ability to take certain actions, such as incurring additional debt or making acquisitions, if we are unable to meet a maximum Net First Lien Leverage Ratio of 5.0 to 1.0 as of the end of each fiscal quarter (the ratio was 1.5 to 1.0 at December 31, 2022). Failure to comply with these covenants could limit our long-term growth prospects by hindering our ability to borrow under the revolver, to obtain future debt and/or to make acquisitions.
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"Adjusted EBITDA" is the term we use to describe EBITDA as defined and adjusted in our credit agreement, which is net income, adjusted for the items summarized in the table below. Adjusted EBITDA is intended to show our unleveraged, pre-tax operating results and therefore reflects our financial performance based on operational factors, excluding non-operational, non-cash or non-recurring losses or gains. It is also provided to aid investors in understanding our compliance with our debt covenants. Adjusted EBITDA is not a presentation made in accordance with GAAP, and our use of the term Adjusted EBITDA varies from others in our industry. This measure should not be considered as an alternative to net income, income from operations or any other performance measures derived in accordance with GAAP. Adjusted EBITDA has important limitations as an analytical tool, and should not be considered in isolation, or as a substitute for analysis of our results as reported under GAAP. For example, Adjusted EBITDA does not reflect: (a) our capital expenditures, future requirements for capital expenditures or contractual commitments; (b) changes in, or cash requirements for, our working capital needs; (c) the significant interest expenses, or the cash requirements necessary to service interest or principal payments, on our debt; (d) tax payments that represent a reduction in cash available to us; (e) any cash requirements for the assets being depreciated and amortized that may have to be replaced in the future; or (f) the impact of earnings or charges resulting from matters that we and the lenders under our credit agreement may not consider indicative of our ongoing operations. In particular, our definition of Adjusted EBITDA allows us to add back certain non-cash, non-operating or non-recurring charges that are deducted in calculating net income, even though these are expenses that may recur, vary greatly and are difficult to predict and can represent the effect of long-term strategies as opposed to short-term results.
In addition, certain of these expenses added back in calculating Adjusted EBITDA can represent the reduction of cash that could be used for other corporate purposes. Further, although not included in the calculation of Adjusted EBITDA below, the measure may at times allow us to add estimated cost savings and operating synergies related to operational changes ranging from acquisitions or dispositions to restructuring, and/or exclude one-time transition expenditures that we anticipate we will need to incur to realize cost savings before such savings have occurred.
The calculation of Adjusted EBITDA under our credit agreement as of December 31, 2022, is presented in the table below. However, the results of such calculation could differ in the future based on the different types of adjustments that may be included in such respective calculations at the time.
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Set forth below is a reconciliation of net income to Adjusted EBITDA for the year ended December 31, 2022.
(in millions) Year Ended December 31, 2022
Net income $ 61.7
Income from discontinued operations, net of tax (1) (4.7)
Provision for income taxes 26.8
Actuarial gain on pension and postretirement benefit obligations (1.9)
Other income, net (2) (1.7)
Interest expense, net 26.9
Depreciation and amortization 54.5
Adjustments to EBITDA
Restructuring and other similar charges (3) 15.4
Stock-based compensation expense 25.0
Merger costs (4) 33.7
LIFO expense (5) 9.7
Acquisition-related fair value adjustment 18.9
Other, net (6) 0.3
Subtotal of adjustments to EBITDA 103.0
Adjusted EBITDA 264.6
Pro forma adjustment for acquisitions (7) 36.2
Pro forma Adjusted EBITDA 300.8
Consolidated indebtedness (8) $ 438.3
Net First Lien Leverage Ratio (9) 1.46
____________________
(1)Income from discontinued operations, net of tax is not included in Adjusted EBITDA in accordance with the terms of our credit agreement.
(2)Other income, net consists primarily of gains and losses from foreign currency transactions, the non-service cost components of net periodic benefit costs associated with our defined benefit plans and other non-operational gains and losses.
(3)Restructuring and other similar charges is comprised of costs associated with workforce reductions, lease termination costs, and other facility rationalization costs. See Item 8, Note 5, Restructuring and Other Similar Charges for more information.
(4)Merger costs is comprised of costs associated with legal and other professional services incurred in connection with completing the merger with Elkay, which are excluded in calculating Adjusted EBITDA as defined in our credit agreement.
(5)Last-in first-out (LIFO) inventory adjustments are excluded in calculating Adjusted EBITDA as defined in our credit agreement.
(6)Other, net consists of gains and losses on the disposition of long-lived assets.
(7)Represents a pro forma adjustment to include Adjusted EBITDA related to the merger with Elkay, which was permitted by our credit agreement. The pro forma adjustment includes the period from January 1, 2022, through the date of the Elkay Merger. See Item 8, Note 3, Acquisitions for more information.
(8)Our credit agreement defines our consolidated indebtedness as the sum of all indebtedness (other than letters of credit or bank guarantees, to the extent undrawn) consisting of indebtedness for borrowed money and capitalized lease obligations, less unrestricted cash, which was $97.6 million (as defined by the credit agreement) at December 31, 2022.
(9)Our credit agreement defines the Net First Lien Leverage Ratio as the ratio of consolidated indebtedness (as described above) to Adjusted EBITDA for the trailing four fiscal quarters.
Liquidity and Capital Resources
Our primary sources of liquidity are available cash and cash equivalents, cash flow from operations, and borrowing availability under our $200.0 million revolving credit facility.
As of December 31, 2022, we had $124.8 million of cash and cash equivalents and $192.5 million of additional borrowing capacity under our revolving credit facility. As of December 31, 2022, the available borrowings under our credit facility were reduced by $7.5 million due to outstanding letters of credit. As of December 31, 2021, we had $96.6 million of cash and cash equivalents and $193.9 million of additional borrowing capacity. As of December 31, 2021, the available borrowings under our credit facility were reduced by $6.1 million, due to outstanding letters of credit.
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Our revolving credit facility is available to fund our working capital requirements, capital expenditures and other general corporate purposes. We believe this resource is adequate for expected needs.
Cash Flows
Amounts below include activities attributable to our discontinued operations, unless otherwise noted. In addition, cash flows for the year ended December 31, 2020 include our continuing operations and discontinued operations for the entire period, while the year ended December 31, 2021 only includes the cash flows associated with our PMC platform for the period from January 1, 2021 to October 4, 2021, the date the Spin-Off Transaction was completed. Refer to Item 8, Note 4 Discontinued Operations for further information.
Year Ended December 31, 2022 Compared with the Year Ended December 31, 2021
Net cash provided by operating activities in the year ended December 31, 2022, was $97.0 million compared to $223.6 million in the year ended December 31, 2021 due to lower net income as a result of the Spin-Off Transaction and timing of payments on accounts payable and accrued expenses.
Cash used for investing activities was $6.6 million in the year ended December 31, 2022 compared to $21.9 million in the year ended December 31, 2021. Investing activities in the year ended December 31, 2022, included $7.6 million of capital expenditures and net cash payments of $44.8 million in connection with acquisitions, which were partially offset by the receipt of $35.0 million from Regal Rexnord Corporation in connection with the final net assets transferred in the PMC Spin-Off Transaction, the receipt of $9.5 million in connection with an insurance settlement and $1.3 million from the sale of certain long-lived assets. Investing activities for the year ended December 31, 2021, included $17.1 million of cash used to fund the acquisitions of Wade and ATS GREASEwatch, $23.3 million of capital expenditures, partially offset by the receipt of $18.5 million in connection with the disposition of certain long-lived assets.
Cash used for financing activities was $61.1 million in the year ended December 31, 2022 compared to cash used for financing activities of $356.2 million in the year ended December 31, 2021. Financing activities in the year ended December 31, 2022 included $32.5 million of cash for the payment of dividends on our common stock, $24.7 million of cash for repurchases of our common stock, $5.7 million of net cash payments on outstanding debt, which were partially offset by $1.8 million of net cash proceeds associated with stock option exercises. During the year ended December 31, 2021, we utilized a net $311.5 million of cash related to the Spin-Off Transaction of PMC, $0.9 million of cash for repurchases of our common stock and $36.4 million of cash for the payment of dividends on our common stock. Cash used for financing activities during the year ended December 31, 2021 also included $24.9 million of cash proceeds associated with stock option exercises, more than offset by $32.3 million of cash used for the payment of withholding taxes on employees' share-based payment awards.
Year Ended December 31, 2021 Compared with the Year Ended December 31, 2020
Net cash provided by operating activities in the year ended December 31, 2021, was $223.6 million compared to $320.2 million in the year ended December 31, 2020 due to lower net income as a result of the Spin-Off Transaction and investments in working capital.
Cash used for investing activities was $21.9 million in the year ended December 31, 2021 compared to $196.6 million in the year ended December 31, 2020. Investing activities in the year ended December 31, 2021, included $17.1 million of net cash used to fund the acquisitions of Wade and ATS GREASEwatch, whereas the year ended December 31, 2020, included $161.4 million of net cash used in connection with acquisitions of Hadrian, Just Manufacturing and the remaining non-controlling interest in a PMC joint venture. We invested $23.3 million in capital expenditures in the year ended December 31, 2021, compared to $44.2 million in the year ended December 31, 2020. We also received $14.3 million in connection with the disposition of certain long-lived assets in the year ended December 31, 2021, compared to $9.0 million in the year ended December 31, 2020.
Cash used for financing activities was $356.2 million in the year ended December 31, 2021 compared to cash used for financing activities of $156.2 million in the year ended December 31, 2020. During the year ended December 31, 2021, we utilized a net $311.5 million of cash related to the Spin-Off Transaction of PMC, $0.9 million of cash for repurchases of our common stock and $36.4 million of cash for the payment of dividends on our common stock. Cash used for financing activities during the year ended December 31, 2021 also included $24.9 million of cash proceeds associated with stock option exercises, more than offset by $32.3 million of cash used for the payment of withholding taxes on employees' share-based payment awards. During the year ended December 31, 2020, we utilized a net $5.7 million of cash for payments on outstanding debt, $140.0 million of cash for repurchases of our common stock and $38.6 million of cash for the payment of dividends on our common stock. Cash used for financing activities during the year ended December 31, 2020 also included $37.5 million of cash proceeds associated with stock option exercises, partially offset by $9.4 million of cash used for the payment of withholding taxes on employees' share-based payment awards.
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Tabular Disclosure of Contractual Obligations
The table below lists our contractual obligations at December 31, 2022 by period when due:
Payments Due by Period
(in millions) Total Less than1 Year 1-3 Years 3-5 Years More than5 Years
Pension and post-retirement plans (3) 35.9 1.5 18.4 16.0 See note (3)
_______________________
(1)Excludes unamortized debt issuance costs of $9.2 million at December 31, 2022.
(2)Interest on long-term debt obligations represents the cash interest expense using LIBOR as of December 31, 2022.
(3)Represents expected pension and post-retirement contributions and benefit payments to be paid directly by the Company. Contributions and benefit payments beyond fiscal 2027 cannot be estimated.
No provision has been made for U.S. federal income taxes related to approximately $19.4 million of undistributed earnings of foreign subsidiaries considered to be permanently reinvested; see Item 8, Note 17 Income Taxes for further information.
We may be required to make significant cash outlays related to our unrecognized tax benefits, including interest and penalties. However, due to the uncertainty of the timing of future cash flows associated with our unrecognized tax benefits, we are unable to make reasonably reliable estimates of the period of cash settlement, if any, with the respective taxing authorities. Accordingly, unrecognized tax benefits, including interest and penalties and federal tax benefits where applicable, of $5.5 million as of December 31, 2022, have been excluded from the contractual obligations table above. See Item 8, Note 17 Income Taxes for more information related to our unrecognized tax benefits.
Additionally, the deferred compensation liability of $12.1 million as of December 31, 2022, has been excluded from the contractual obligations table above, as we are unable to reasonably estimate the timing of the payments or the amount by which the liability will increase over time. See Item 8, Note 16, Retirement Benefits for more information related to our deferred compensation plan.
Our pension and post-retirement benefit plans are discussed in detail in Item 8, Note 16, Retirement Benefits. The pension plans provide for monthly pension payments to eligible employees upon retirement. Other post-retirement benefits consist of retiree medical plans that cover a portion of employees in the United States that meet certain age and service requirements and other post-retirement benefits for employees at certain foreign locations. See Item 1A, Risk Factors for more information.
Indebtedness
As of December 31, 2022 we had $535.9 million of total indebtedness outstanding as follows (in millions):
____________________
(1)Includes unamortized original issue discount and debt issuance costs of $9.2 million at December 31, 2022.
See Item 8, Note 11, Long-Term Debt for a description of our outstanding indebtedness.
Off-Balance Sheet Arrangements
We do not have any off-balance sheet or non-consolidated special-purpose entities.
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Quantitative and Qualitative Disclosures about Market Risk
We are exposed to market risk during the normal course of business from changes in foreign currency exchange rates and interest rates. The exposure to these risks is managed through a combination of normal operating and financing activities and at times derivative financial instruments in the form of foreign currency forward contracts to cover certain known foreign currency transactional risks. We also have historically entered into interest rate derivatives to manage interest rate fluctuations.
Foreign Currency Exchange Rate Risk
Our exposure to foreign currency exchange rates relates primarily to our operations in Canada. For our operations in Canada, exchange rates impact the U.S. Dollar ("USD") value of our reported earnings, our investments in the subsidiaries and the intercompany transactions with the subsidiaries.
Approximately 11% of our sales originated outside of the United States in the year ended December 31, 2022. Revenues and expenses denominated in foreign currencies are translated into USD at the end of the fiscal period using the average exchange rates in effect during the period. Fluctuations in currency exchange rates also impact the USD amount of our stockholders' equity. The assets and liabilities of our non-U.S. subsidiaries are translated into USD at the exchange rates in effect at the end of the fiscal periods. As of December 31, 2022, stockholders' equity decreased by $4.2 million from December 31, 2021 as a result of foreign currency translation adjustments. If the USD strengthened by 10% as of December 31, 2022, the result would have decreased stockholders' equity by approximately $11.2 million.
As of December 31, 2022, we had not entered into foreign currency forward contracts.
Interest Rate Risk
Our indebtedness under the senior secured credit facilities bears interest at rates that fluctuate with changes in certain short-term prevailing interest rates. As of December 31, 2022, our outstanding borrowings under the term loan facility were $535.3 million (net of $9.2 million unamortized debt issuance costs) and bore an effective interest rate of 6.39%, determined as London Interbank Offered Rate ("LIBOR") (subject to a 0.5% floor) plus an applicable margin of 2.00%. During the year ended December 31, 2022, the weighted-average interest rate was 4.00%.
Our net income is affected by changes in market interest rates on our variable-rate obligations. As discussed above, our term loan facilities bear interest at LIBOR (subject to a 0.5% floor) plus an applicable margin. Therefore, a 100 basis point increase in LIBOR above where it closed as of December 31, 2022 would increase the annual interest expense under our term loan facility by approximately $5.5 million.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The information with respect to the Company's market risk is contained under the caption "Quantitative and Qualitative Disclosures About Market Risk" in Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations.
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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The consolidated financial statements included in this Form 10-K include the accounts of Zurn Elkay Water Solutions Corporation and subsidiaries (collectively, the "Company").
Index to Financial Statements
Zurn Elkay Water Solutions Corporation and Subsidiaries
Consolidated Financial Statements
As of December 31, 2022 and 2021 and for the years ended December 31, 2022 and December 31, 2021,
and the nine-month Transition Period ended December 31, 2020
Consolidated Balance Sheets 46
Consolidated Statements of Operations 47
Consolidated Statements of Comprehensive Income 48
Consolidated Statements of Stockholders' Equity 49
Consolidated Statements of Cash Flows 50
Notes to Consolidated Financial Statements 51
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Report of Independent Registered Public Accounting Firm
To the Stockholders and the Board of Directors of Zurn Elkay Water Solutions Corporation
Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheets of Zurn Elkay Water Solutions Corporation and Subsidiaries (the Company) as of December 31, 2022 and 2021, the related consolidated statements of operations, comprehensive income, stockholders' equity and cash flows for the years ended December 31, 2022 and 2021 and the nine months ended December 31, 2020 and the related notes and financial statement schedule listed in the Index at Item 15(a)(2) (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company at December 31, 2022 and 2021, and the results of its operations and its cash flows for the years ended December 31, 2022 and 2021 and the nine months ended December 31, 2020, in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company's internal control over financial reporting as of December 31, 2022, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) and our report dated February 14, 2023 expressed an unqualified opinion thereon.
Basis for Opinion
These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
Critical Audit Matter
The critical audit matter communicated below is a matter arising from the current period audit of the financial statements that was communicated or required to be communicated to the audit committee and that: (1) relate to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective or complex judgments. The communication of the critical audit matter does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the account or disclosure to which it relates.
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Valuation of acquired intangible assets
/s/ Ernst & Young LLP
We have served as the Company’s auditor since 2002.
Milwaukee, Wisconsin
February 14, 2023
44
Report of Independent Registered Public Accounting Firm
To the Stockholders and the Board of Directors of Zurn Elkay Water Solutions Corporation
Opinion on Internal Control over Financial Reporting
We have audited Zurn Elkay Water Solutions Corporation and Subsidiaries’ internal control over financial reporting as of December 31, 2022, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) (the COSO criteria). In our opinion, Zurn Elkay Water Solutions Corporation and Subsidiaries’ (the Company) maintained, in all material respects, effective internal control over financial reporting as of December 31, 2022, based on the COSO criteria.
As indicated in the accompanying Management’s Report on Internal Control Over Financial Reporting, management’s assessment of and conclusion on the effectiveness of internal control over financial reporting did not include the internal controls of Elkay Manufacturing Company, which is included in the 2022 consolidated financial statements of the Company and constituted $1,248.7 million and $912.0 million of total and net assets, respectively, as of December 31, 2022 and net sales of $264.4 million and a net loss of $11.5 million, for the year then ended. Our audit of internal control over financial reporting of the Company also did not include an evaluation of the internal control over financial reporting of Elkay Manufacturing Company.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheets of the Company as of December 31, 2022 and December 31, 2021, the related consolidated statements of operations, comprehensive income, stockholders’ equity and cash flows for the years ended December 31, 2022 and 2021, and the nine months ended December 31, 2020 and the related notes and financial statement schedule listed in the Index at Item 15(a)(2) and our report dated February 14, 2023 expressed an unqualified opinion thereon.
Basis for Opinion
The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects.
Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
Definition and Limitations of Internal Control Over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
/s/ Ernst & Young LLP
Milwaukee, Wisconsin
February 14, 2023
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Zurn Elkay Water Solutions Corporation and Subsidiaries
Consolidated Balance Sheets
(in Millions, except share amounts)
Assets
Current assets:
Cash and cash equivalents $ 124.8 $ 96.6
Income taxes receivable 18.3 33.1
Property, plant and equipment, net 183.8 64.4
Insurance for asbestos claims 72.1 66.0
Liabilities and stockholders' equity
Current liabilities:
Current maturities of debt $ 5.7 $ 5.6
Compensation and benefits 19.2 22.0
Current portion of pension and postretirement benefit obligations 1.6 1.3
Pension and postretirement benefit obligations 50.5 57.3
Deferred income taxes 221.4 3.1
Operating lease liability 34.2 8.9
Reserve for asbestos claims 79.0 66.0
Stockholders' equity:
Accumulated other comprehensive loss (75.0) (74.9)
Total liabilities and stockholders' equity $ 2,864.0 $ 1,077.7
See notes to consolidated financial statements.
46
Zurn Elkay Water Solutions Corporation and Subsidiaries
Consolidated Statements of Operations
(in Millions, except share and per share amounts)
Year Ended Nine-Month Transition Period Ended
Selling, general and administrative expenses 309.0 239.0 153.7
Restructuring and other similar charges 15.4 3.7 1.7
Amortization of intangible assets 34.0 23.5 16.9
Non-operating expense:
Loss on the extinguishment of debt — (20.4) —
Other income (expense), net 1.7 (0.7) (1.9)
Provision for income taxes (26.8) (2.7) (10.5)
Net income from continuing operations 57.0 49.7 35.0
Income from discontinued operations, net of tax 4.7 71.2 83.2
Basic net income per share:
Diluted net income per share:
Weighted-average number of common shares outstanding (in thousands):
See notes to consolidated financial statements.
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Zurn Elkay Water Solutions Corporation and Subsidiaries
Consolidated Statements of Comprehensive Income
(in Millions)
Year Ended Nine-Month Transition Period Ended
Other comprehensive income:
Foreign currency translation adjustments (4.2) (4.2) 37.8
Other comprehensive (loss) income, net of tax (0.1) 14.2 50.6
See notes to consolidated financial statements.
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Zurn Elkay Water Solutions Corporation and Subsidiaries
Consolidated Statements of Stockholders’ Equity
(in Millions)
Foreign currency translation and other adjustments — — — 37.8 — 37.8
Acquisition of non-controlling interest — (0.2) — — (0.1) (0.3)
Stock-based compensation expense — 35.9 — — — 35.9
Proceeds from exercise of stock options — 18.3 — — — 18.3
Repurchase of common stock (2) — — (59.3) — — (59.3)
Common stock dividends ($0.24 per share) — — (28.8) — — (28.8)
Net income $ — $ — $ 120.9 $ — $ — $ 120.9
Foreign currency translation and other adjustments — — — (4.2) — (4.2)
Stock-based compensation expense — 51.4 — — — 51.4
Proceeds from exercise of stock options 0.1 24.9 — — — 25.0
Repurchase of common stock (2) — — (0.9) — — (0.9)
Dividend received from Spin-Off Transaction — — 486.8 — — 486.8
Common stock dividends ($0.30 per share) — — (36.4) — — (36.4)
Net income $ — $ — $ 61.7 $ — $ — $ 61.7
Foreign currency translation and other adjustments — — — (4.2) — (4.2)
Total comprehensive income (loss) — — 61.7 (0.1) — 61.6
Stock-based compensation expense — 23.2 — — — 23.2
Proceeds from exercise of stock options — 2.5 — — — 2.5
Repurchase of common stock (2) — — (24.7) — — (24.7)
Common stock dividends ($0.20 per share) — (25.3) — — — (25.3)
____________________
(1) During the Transition Period, the Company acquired the remaining 30% non-controlling interest in a PMC controlled subsidiary for a cash purchase price of $0.3 million. From the time of this transaction through the Spin-Off Transaction, non-controlling interest represents a 5% non-controlling interest in another PMC joint venture relationship. The Company has no remaining non-controlling interest subsequent to the Spin-Off Transaction.
(2) During the years ended December 31, 2022 and 2021 and the nine-month Transition Period ended December 31, 2020, the Company repurchased and canceled 1.1 million shares, 22,300 shares and 1.7 million shares of common stock at a total cost of $24.7 million, $0.9 million and $59.3 million at a weighted average price of $23.00, $39.27 and $34.97 per share, respectively. See Note 19 Common Stock Repurchases for additional information.
(3) Refer to Note 3, Acquisitions for additional information regarding the Elkay Merger.
See notes to consolidated financial statements.
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Zurn Elkay Water Solutions Corporation and Subsidiaries
Consolidated Statements of Cash Flows
(in Millions)
Year Ended Nine-Month Transition Period Ended
Operating activities
Adjustments to reconcile net income to cash provided by operating activities:
Amortization of intangible assets 34.0 33.4 27.0
Loss (gain) on dispositions of long-lived assets 0.3 (10.1) (1.1)
Deferred income taxes 0.5 (12.1) (7.0)
Other non-cash expenses (income) 4.8 (3.6) 0.2
Loss on the extinguishment of debt — 20.4 —
Stock-based compensation expense 25.0 51.4 36.6
Changes in operating assets and liabilities:
Investing activities
Expenditures for property, plant and equipment (7.6) (23.3) (28.3)
Acquisitions, net of cash acquired (44.8) (17.1) (102.0)
Proceeds from dispositions of long-lived assets 1.3 14.3 7.8
Proceeds from insurance claims 9.5 — —
Proceeds associated with divestiture of discontinued operations 35.0 4.2 —
Cash used for investing activities (6.6) (21.9) (122.5)
Financing activities
Dividend received from Spin-Off Transaction of PMC — 486.8 —
Cash transferred to PMC related to Spin-Off Transaction — (192.8) —
Payment of debt issuance costs — (28.8) —
Proceeds from exercise of stock options 2.5 24.9 18.3
Repurchase of common stock (24.7) (0.9) (59.3)
Payment of common stock dividends (32.5) (36.4) (28.8)
Cash used for financing activities (61.1) (356.2) (409.6)
____________________
(1) The Company has combined cash flows from discontinued operations with cash flows from continuing operations within operating, investing and financing categories. As such cash and cash equivalents and restricted cash include $193.3 million of cash and cash equivalents from the discontinued operation as of December 31, 2020.
See notes to consolidated financial statements.
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Zurn Elkay Water Solutions Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2022
1. Basis of Presentation and Description of Business
The consolidated financial statements included herein have been prepared by Zurn Elkay Water Solutions Corporation ("Zurn Elkay" or the "Company"), in accordance with accounting principles generally accepted in the United States ("GAAP") pursuant to the rules and regulations of the Securities and Exchange Commission. The consolidated financial statements include the accounts of the Company and its subsidiaries. All intercompany balances and transactions have been eliminated in consolidation. In the opinion of management, the consolidated financial statements include all adjustments necessary for a fair presentation of the financial position and the results of operations for the periods presented.
Following the end of the Company's fiscal year ended March 31, 2020, the Company transitioned to a December 31 fiscal year-end date. As a result, this Form 10-K includes financial information for the nine-month period from April 1, 2020 to December 31, 2020 (the "Transition Period"). Prior to the Transition Period, the Company’s fiscal year ended on March 31 of each year.See Note 12, Comparative Twelve Month Financial Information for additional information.
Elkay Merger
On February 12, 2022, Zurn Water Solutions Corporation (“Zurn”) entered into a definitive agreement to combine with Elkay Manufacturing Company (“Elkay”), pursuant to an Agreement and Plan of Merger (the “Merger Agreement”) by and among Zurn, Elkay, Zebra Merger Sub, Inc., a wholly owned subsidiary of Zurn (“Merger Sub”), and Elkay Interior Systems International, Inc., as representative of the stockholders of Elkay, providing for the merger of Elkay with and into Merger Sub, with Elkay surviving as a wholly owned subsidiary of Zurn (the “Merger”). On July 1, 2022, the Merger was completed following which the Company changed its name to “Zurn Elkay Water Solutions Corporation” (“Zurn Elkay”, "we", "us", "our", or the “Company”). Shares of the Company's common stock continue to trade on the New York Stock Exchange under the ticker symbol “ZWS”. See Note 3, Acquisitions, for additional information.
Spin-Off of Process & Motion Control Segment
On October 4, 2021, the Company completed a Reverse Morris Trust tax-free spin-off transaction (the “Spin-Off Transaction”) in which (i) substantially all the assets and liabilities of the Company's PMC business were transferred to a newly created subsidiary, Land Newco, Inc. (“Land”), (ii) the shares of Land were distributed to the Company's stockholders pro rata, and (iii) Land was merged with a subsidiary of Regal Rexnord Corporation (formerly known as Regal Beloit Corporation), in which the stock of Land was converted into a specified number of shares of Regal Rexnord Corporation in accordance with the exchange ratio. Following completion of the Spin-Off Transaction, the Company's name was changed to “Zurn Water Solutions Corporation” and the ticker symbol for its shares of common stock trading on the New York Stock Exchange was changed to “ZWS”.
As a result of the Spin-Off Transaction, in accordance with the authoritative guidance, the operating results of PMC are reported as discontinued operations in the consolidated statements of operations for all periods presented. The consolidated statements of cash flows for the year ended December 31, 2022, the year ended December 31, 2021 and the nine-month Transition Period ended December 31, 2020 have not been adjusted to separately disclose cash flows related to the discontinued operations. See Note 4, Discontinued Operations for additional information.
In connection with the Spin-Off Transaction, the Company separated certain defined benefit pension and other post-employment benefit plans, and adjusted its employee share-based compensation awards. See Note 15 Stock-Based Compensation and Note 16 Retirement Benefits, respectively, for additional information.
The Company
Zurn Elkay Water Solutions Corporation is a growth-oriented, pure-play water management business that designs, procures, manufactures, and markets what the Company believes to be the broadest sustainable product portfolio of specification-driven water management solutions to improve health, human safety and the environment. The Company's product portfolio includes professional grade water safety and control products, flow system products, hygienic and environmental products, and drinking water products for public and private spaces that deliver superior value to building owners, positively impact the environment and human hygiene and reduce product installation time. The Companmy's heritage of innovation and specification has allowed it to provide highly-engineered, mission-critical solutions to customers for decades and affords it the privilege of having long-term, valued relationships with market leaders. The Company operates in a disciplined way and the Zurn Elkay Business System (“ZEBS”), described below, is its operating philosophy. Grounded in the spirit of continuous improvement, ZEBS creates a scalable, process-based framework that focuses on driving superior customer satisfaction and financial results by targeting world-class operating performance throughout all aspects of its business.
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2. Significant Accounting Policies
Use of Estimates
The preparation of financial statements in accordance with GAAP requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates.
Revenue Recognition
See Note 6, Revenue Recognition for the Company's policy for recognizing revenue under Accounting Standards Codification ("ASC") 606, Revenue from Contracts with Customers ("ASC 606") as well as the various other disclosures required by ASC 606.
Leases
The Company determines if an arrangement is a lease, or contains a lease, at the inception of the arrangement and determines whether it is an operating or financing lease. Operating and financing leases result in the Company recording a right-of-use ("ROU") asset, current lease liability, and long-term lease liability on its balance sheet. Lease expense for operating leases and amortization expense for finance leases is recognized on a straight-line basis over the lease term. Leases with an initial term of 12 months or less are not recorded on the consolidated balance sheet and are instead recognized on a straight-line basis over the lease term. See Note 14, Leases, for additional discussion about the Company's policy for accounting for leases and other required disclosures.
Stock-Based Compensation
The Company accounts for stock-based compensation in accordance with ASC 718, Accounting for Stock Compensation ("ASC 718"). ASC 718 requires compensation costs related to stock-based payment transactions to be recognized in the financial statements. Generally, compensation cost is measured based on the grant-date fair value of the equity instruments issued. Compensation cost is recognized over the requisite service period, generally as the awards vest. See further discussion of the Company’s equity plans in Note 15, Stock-Based Compensation.
Cash and Cash Equivalents
The Company considers all highly liquid investments with a maturity of three months or less to be cash and cash equivalents.
Receivables
Receivables are stated net of allowances for doubtful accounts of $1.4 million at December 31, 2022, and $1.2 million at December 31, 2021. The Company assesses the collectability of customer receivables based on the credit worthiness of a customer as determined by credit checks and analysis, as well as the customer’s payment history. In determining the allowance for doubtful accounts, the Company also considers various factors including the aging of customer accounts and historical write-offs. In addition, the Company monitors other risk factors, including forward-looking information when establishing adequate allowances for doubtful accounts, which reflects the current estimate of credit losses expected to be incurred over the life of the receivables. Generally, advance payment is not required. Allowances for doubtful accounts established are recorded within selling, general and administrative expenses within the consolidated statements of operations.
Significant Customers
The Company’s largest customer accounted for 22%, 23% and 24% of consolidated net sales for the year ended December 31, 2022, the year ended December 31, 2021, and the nine-month Transition Period ended December 31, 2020, respectively. No other customers account for more than 10% of consolidated net sales for the year ended December 31, 2022, the year ended December 31, 2021, or the nine-month Transition Period ended December 31, 2020.
Inventories
Inventories are comprised of material, direct labor and manufacturing overhead, and are stated at the lower of cost or market. Market is determined based on estimated net realizable values. The Company’s total inventories valued using the "last-in, first-out" (LIFO) method was 89% and 84% at December 31, 2022 and 2021, respectively. All remaining inventories are valued using the "first-in, first-out" (FIFO) method.
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In some cases, the Company has determined a certain portion of inventories are excess or obsolete. In those cases, the Company writes down the value of those inventories to their net realizable value based upon assumptions about future demand and market conditions. If actual market conditions are less favorable than those projected by management, adjustments to established inventory reserves may be required. The total write-down of inventories charged to expense was $0.8 million, $0.9 million and $1.5 million, during the year ended December 31, 2022, the year ended December 31, 2021, and the nine-month Transition Period ended December 31, 2020, respectively.
Property, Plant and Equipment
Property, plant and equipment are initially stated at cost. Depreciation is provided using the straight-line method over 10 to 30 years for buildings and improvements, 5 to 10 years for machinery and equipment and 3 to 5 years for computer hardware and software. Where appropriate, the depreciable lives of certain assets may be adjusted to reflect a change in the use of those assets, or depreciation may be accelerated in the case of an eventual asset disposal.
Goodwill and Intangible Assets
Intangible assets consist of acquired trademarks and tradenames, customer relationships (including distribution network) and patents. The customer relationships, patents, and certain tradenames are being amortized using the straight-line method over their estimated useful lives of 7 to 20 years, 3 to 10 years and 5 to 20 years, respectively. Where appropriate, the lives of certain intangible assets may be adjusted to reflect a change in the use of those assets, or amortization may be accelerated in the case of a known intangible asset discontinuation.
Goodwill, trademarks and certain tradenames have indefinite lives and are not amortized. However, the goodwill and intangible assets are tested annually for impairment, and may be tested more frequently if any triggering events occur that would reduce the recoverability of the asset. In conducting the annual impairment test for goodwill, the Company has the option to first assess qualitative factors to determine whether it is more likely than not (> 50% likelihood) the fair value of any reporting unit is less than its carrying amount. If a qualitative assessment determines an impairment is more likely than not, the Company is required to perform a quantitative impairment test. Otherwise, no further analysis is required. Alternatively, the Company may elect to proceed directly to the quantitative impairment test. In conducting a qualitative assessment, the Company utilizes a discounted cash flow methodology based on future business projections and a market value approach (guideline public company comparables). The Company performs the goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. If the carrying amount exceeds the fair value of the reporting unit, an impairment charge is recognized for the amount by which the carrying amount exceeds the reporting unit's fair value up to the amount of the recorded goodwill.
During the fourth quarter of the year ended December 31, 2022, the Company completed its annual goodwill impairment tests and elected to perform a qualitative assessment. No goodwill impairment charges were recorded during the year ended December 31, 2022, the year ended December 31, 2021, or the nine-month Transition Period ended December 31, 2020.
Impairment of Long-Lived Assets
The carrying value of long-lived assets, including amortizable intangible assets and tangible fixed assets, are evaluated for impairment whenever events or changes in circumstances indicate that the related carrying amounts may not be recoverable. Impairment of amortizable intangible assets and tangible fixed assets is generally determined by comparing projected undiscounted cash flows to be generated by the asset, or group of assets, to its carrying value. If impairment is identified, a loss is recorded equal to the excess of the asset's net book value over its fair value, and the cost basis is adjusted accordingly. The Company recognized no impairment charges of tangible fixed assets during the during the year ended December 31, 2022, the year ended December 31, 2021, or the nine-month Transition Period ended December 31, 2020, respectively. Impairments are determined utilizing Level 3 inputs within the Fair Value hierarchy, and the Company reviews and considers input from outside specialists, when appropriate. Actual results could vary from these estimates. Refer to Note 13, Fair Value Measurements for additional information.
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Product Warranty
The Company offers warranties on the sales of certain of its products and records an accrual for estimated future claims. Such accruals are based upon historical experience and management’s estimate of the level of future claims.The following table presents changes in the Company’s product warranty liability during each of the periods presented (in millions):
Year Ended Nine-Month Transition Period Ended
Balance at beginning of period $ 1.3 $ 1.2 $ 1.4
Acquired obligations 3.5 0.3 —
Charged to operations 1.6 1.1 0.7
Claims settled (2.2) (1.3) (0.9)
Balance at end of period $ 4.2 $ 1.3 $ 1.2
Income Taxes
Deferred income taxes are provided for future tax effects attributable to temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases, net operating losses, tax credits and other applicable carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be actually paid or recovered. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the results of continuing operations in the period that includes the date of enactment.
The Company regularly reviews its deferred tax assets for recoverability and provides a valuation allowance against its deferred tax assets if, based upon consideration of all positive and negative evidence, the Company determines that it is more-likely-than-not that a portion or all of the deferred tax assets will ultimately not be realized in future tax periods. Such positive and negative evidence would include review of historical earnings and losses, anticipated future earnings, the time period over which the temporary differences and carryforwards are anticipated to reverse and implementation of feasible, prudent tax planning strategies.
The Company is subject to income taxes in the United States and numerous foreign jurisdictions. Significant judgment is required in determining the Company’s worldwide provision for income taxes and recording the related deferred tax assets and liabilities. In the ordinary course of the Company’s business, there is inherent uncertainty in quantifying the ultimate tax outcome of all the numerous transactions and required calculations relating to the Company’s tax positions. Accruals for unrecognized tax benefits are provided for in accordance with the requirements of ASC 740, Income Taxes ("ASC 740"). An unrecognized tax benefit represents the difference between the recognition of benefits related to uncertain tax positions for income tax reporting purposes and financial reporting purposes. The Company has established a reserve for interest and penalties, as applicable, for uncertain tax positions and it is recorded as a component of the overall income tax provision.
The Company is subject to periodic income tax examinations by domestic and foreign income tax authorities. Although the outcome of income tax examinations is always uncertain, the Company believes that it has appropriate support for the positions taken on its income tax returns and has adequately provided for potential income tax assessments. Nonetheless, the amounts ultimately settled relating to issues raised by the taxing authorities may differ materially from the amounts accrued for each year.
See Note 17, Income Taxes for additional information.
Per Share Data
Basic net income per share from continuing and discontinued operations is computed by dividing net income from continuing operations and income from discontinued operations, respectively, by the corresponding weighted average number of common shares outstanding for the period. Diluted net income per share from continuing and discontinued operations is computed based on the weighted average number of common shares outstanding, increased by the number of incremental shares that would have been outstanding if the potential dilutive shares were issued through the exercise of outstanding stock options to purchase common shares, except when the effect would be anti-dilutive.
The computation for diluted net income per share for the year ended December 31, 2022, the year ended December 31, 2021, and the nine-month Transition Period ended December 31, 2020 excludes 0.4 million, 0.7 million and 0.5 million common shares due to their anti-dilutive effects, respectively.
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Accumulated Other Comprehensive Loss
The changes in accumulated other comprehensive loss, net of tax, for the year ended December 31, 2022, the year ended December 31, 2021, and the nine-month Transition Period ended December 31, 2020 are as follows (in millions):
Foreign Currency Translation and Other Pension and Postretirement Plans Total
Other comprehensive income before reclassifications 37.8 13.0 50.8
Amounts reclassified from accumulated other comprehensive loss — (0.2) (0.2)
Other comprehensive (loss) income before reclassifications (4.2) 14.9 10.7
Amounts reclassified from accumulated other comprehensive loss — 3.5 3.5
PMC Spin-Off Transaction (20.7) 5.4 (15.3)
Other comprehensive (loss) income before reclassifications $ (4.2) $ 4.1 $ (0.1)
Amounts reclassified from accumulated other comprehensive loss — — —
The following table summarizes the amounts reclassified from accumulated other comprehensive loss to net income during the year ended December 31, 2022, the year ended December 31, 2021, and the nine-month Transition Period ended December 31, 2020 (in millions):
PMC Spin-Off Transaction settlement — 4.8 — Discontinued operations, net of tax
Benefit (provision) for income taxes — (1.1) —
Total, net of income taxes $ — $ 3.5 $ (0.2)
Foreign Currency Translation
Assets and liabilities of subsidiaries operating outside of the United States with a functional currency other than the U.S. dollar are translated into U.S. dollars using exchange rates at the end of the respective period. Revenues and expenses of such entities are translated at average exchange rates in effect during the respective period. Foreign currency translation adjustments are included as a component of accumulated other comprehensive loss. Currency transaction (gains) losses are included in other expense, net in the consolidated statements of operations and totaled $1.0 million, $0.4 million and $(0.4) million for the year ended December 31, 2022, the year ended December 31, 2021, and the nine-month Transition Period ended December 31, 2020, respectively.
Advertising Costs
Advertising costs are charged to selling, general and administrative expenses on the consolidated statements of operations as incurred and amounted to $12.5 million, $8.2 million and $5.5 million for the year ended December 31, 2022, the year ended December 31, 2021, and the nine-month Transition Period ended December 31, 2020, respectively.
Research, Development and Engineering Costs
Research, development and engineering costs are charged to selling, general and administrative expenses on the consolidated statements of operations as incurred and amounted to $18.4 million, $14.0 million and $9.6 million for the year ended December 31, 2022, the year ended December 31, 2021, and the nine-month Transition Period ended December 31, 2020, respectively.
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Business Segment and Geographic Areas
The Company is a pure-play water management business that designs, procures, manufactures, and markets specification-driven water management solutions to improve health, human safety and the environment, which comprises one reportable segment. The Company manages and evaluates its operations as one segment primarily due to similarities in the nature of its products, production process, customers and methods of distribution.
Net sales to third parties and long-lived assets by geographic region are as follows (in millions):
Net Sales Long-lived Assets
Net sales to third parties are attributed to the geographic regions based on the country in which the shipment originates. Amounts attributed to the geographic regions for long-lived assets are based on the location of the entity that holds such assets. In accordance with ASC 280, Segment Reporting, long-lived assets includes movable assets and excludes net intangible assets and goodwill.
Concentrations of Credit Risk
Financial instruments that potentially subject the Company to significant concentrations of credit risk consist of cash and temporary investments and trade accounts receivable.
Recent Accounting Pronouncements
In December 2022, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") ASU No. 2022-06, Reference Rate Reform (Topic 848): Deferral of the Sunset Date of Topic 848 ("ASU 2022-06"). In 2020, the Board issued Accounting Standards Update No. 2020-04, Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting, which is described below. The Board included a sunset provision within Topic 848 based on expectations of when the London Interbank Offered Rate (LIBOR) would cease being published. At the time that Update 2020-04 was issued, the UK Financial Conduct Authority (FCA) had established its intent that it would no longer be necessary to persuade, or compel, banks to submit to LIBOR after December 31, 2021. As a result, the sunset provision was set for December 31, 2022—12 months after the expected cessation date of all currencies and tenors of LIBOR. In March 2021, the FCA announced that the intended cessation date of the overnight 1-, 3-, 6-, and 12-month tenors of USD LIBOR would be June 30, 2023, which is beyond the current sunset date of Topic 848. Because the current relief in Topic 848 may not cover a period of time during which a significant number of modifications may take place, the amendments in this Update defer the sunset date of Topic 848 from December 31, 2022, to December 31, 2024, after which entities will no longer be permitted to apply the relief in Topic 848. The amendments in this ASU are effective for all entities upon issuance of the update. The Company did not modify any material contracts due to reference rate reform during the year ended December 31, 2022. The Company will continue to evaluate the impact this guidance will have on its consolidated financial statements for all future transactions affected by reference rate reform during the time permitted.
In March 2020, the FASB issued ASU No. 2020-04, Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting ("ASU 2020-04"). The amendments in this update provide optional expedients and exceptions for applying GAAP to contracts, hedging relationships, and other transactions affected by reference rate reform if certain criteria are met. The amendments in this ASU apply only to contracts, hedging relationships, and other transactions that reference LIBOR or another reference rate that is expected to be discontinued because of reference rate reform. The expedients and exceptions provided by the amendments do not apply to contract modifications made and hedging relationships entered into or evaluated after December 31, 2022, except for hedging relationships existing as of December 31, 2022, that an entity has elected certain optional expedients for and that are retained through the end of the hedging relationship. The amendments in this ASU are effective for all entities as of March 12, 2020 through December 31, 2022. The Company did not modify any material contracts due to reference rate reform during the year ended December 31, 2022.
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3. Acquisitions
Year Ended December 31, 2022
On July 1, 2022, the Company and Elkay completed the Elkay Merger for a preliminary purchase price of $1,462.9 million. Elkay, a market leader of commercial sinks and drinking water solutions, complements the Company's existing product portfolio. The preliminary purchase price includes $1,417.0 million of Zurn's common stock based on Zurn's closing stock price of $27.48 on July 1, 2022, and $45.9 million of net cash payments for the repayment of Elkay's term loan and Elkay's transaction related costs outstanding that were in excess of Elkay's cash and cash equivalents at the time of closing. Pursuant to the terms of the Merger Agreement, the Company issued 51,564,524 shares of its common stock, which represented approximately 29% of outstanding shares immediately following the Merger. The total number of shares of the Company's common stock issued at closing was preliminary and subject to change upon finalization of customary post-closing adjustments with respect to cash, indebtedness and working capital. The Company expects that approximately 186,000 of these shares will be returned to the Company in the first half of calendar year 2023 as a result of lower working capital and cash balances at closing compared to targets stipulated in the Merger Agreement. The Company incurred transaction-related costs of approximately $33.7 million for the twelve months ended December 31, 2022. These costs were associated with legal and professional services and were recognized as selling, general and administrative expenses in the consolidated statements of operations.
In accordance with the Merger Agreement, the Company increased the size of its Board to eleven members, and appointed two directors designated by Elkay. As of December 31, 2022, the Board consisted of ten members, including one director designated by Elkay. Zurn senior management immediately prior to the consummation of the Elkay Merger remained as the executive officers of the Company immediately after the Elkay Merger. The Company's management determined that the Company is the accounting acquirer in the Elkay Merger based on the facts and circumstances noted within this section and other relevant factors. As such, the Company applied the acquisition method of accounting to the identifiable assets and liabilities of the Elkay business, which have been measured at estimated fair value as of the date of the business combination.
Elkay’s assets and liabilities were measured at estimated fair value at July 1, 2022, primarily using Level 3 inputs. Estimates of fair value represent management’s best estimate of assumptions about future events and uncertainties, including significant judgments related to future cash flows, discount rates, competitive trends, margin and revenue growth assumptions including royalty rates and customer attrition rates and others. Inputs used were generally obtained from historical data supplemented by current and anticipated market conditions and growth rates expected as of the Merger date. See Note 13, Fair Value Measurements, for additional information. Due to the timing of the business combination and the nature of the net assets acquired, at December 31, 2022, the valuation process to determine the fair values is not complete and further adjustments are expected. The Company has estimated the preliminary fair value of net assets acquired based on information currently available and will continue to adjust those estimates as additional information becomes available. As the Company finalizes the fair value of assets acquired and liabilities assumed, additional purchase price allocation adjustments will be recorded during the measurement period, but no later than one year from the date of the Merger. The Company will reflect measurement period adjustments in the period in which the adjustments are determined.
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The preliminary fair value of the assets acquired and liabilities assumed were as follows (in millions):
Assets acquired:
Receivables, net $ 92.1 $ — $ 92.1
Other current assets 9.9 (1.3) 8.6
Liabilities assumed:
Trade payables $ 30.4 $ — $ 30.4
Current portion of pension and postretirement benefit obligations 17.3 — 17.3
Pension and postretirement benefit obligations 3.6 — 3.6
Total preliminary purchase price $ 1,462.9 $ — $ 1,462.9
Unaudited Pro Forma Information
The following unaudited supplemental pro forma financial information presents the financial results from continuing operations for the year ended December 31, 2022 and 2021 as if the Elkay Merger had occurred on January 1, 2021. The pro forma financial information includes, where applicable, adjustments for: (i) additional amortization expense that would have been recognized related to the acquired intangible assets, (ii) additional depreciation expense that would have been recognized related to the acquired property, plant, and equipment, (iii) transaction costs and other one-time non-recurring costs which reduced expenses by $33.7 million for the year ended December 31, 2022 and increased expenses by $33.7 million for the year ended December 31, 2021, (v) additional cost of sales related to the inventory valuation adjustment which reduced expenses by $18.3 million for the year ended December 31, 2022 and increased expenses by $18.3 million for the year ended December 31, 2021, and (vi) the estimated income tax effect on the pro forma adjustments. The pro forma financial information excludes adjustments for estimated cost synergies or other effects of the integration of the Elkay Merger.
The pro forma financial information is presented for illustrative purposes only and is not necessarily indicative of the operating results that would have been achieved had the Elkay Merger been completed as of the date indicated or the results that may be obtained in the future.
Year Ended
Net income (loss) from continuing operations $ 91.1 $ (4.2)
Earnings per share from continuing operations
Assuming dilution $ 0.59 $ (0.03)
For the period from July 1, 2022 through December 31, 2022, Elkay had net sales and a net loss of $264.4 million and $11.5 million, respectively, which amounts include the impact of purchase accounting adjustments, and are included in the consolidated statements of operations for the period from July 1, 2022 through December 31, 2022.
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Year Ended December 31, 2021
On November 17, 2021, the Company completed the acquisition of the Wade Drains business ("Wade") from McWane, Inc. for a cash purchase price of $12.6 million, excluding transaction costs and net of cash acquired. During the twelve months ended December 31, 2022, the Company received a $1.1 million cash payment from the sellers of Wade in connection with finalizing the acquisition date trade working capital, which is included in the total cash purchase price above. Wade manufactures a wide range of specified commercial plumbing products for customers across North America and complements the Company's existing flow systems product portfolio.
On April 16, 2021, the Company acquired substantially all of the assets of Advance Technology Solutions, LLC (d/b/a ATS GREASEwatch) ("ATS GREASEwatch") for a cash purchase price of $4.5 million, excluding transaction costs and net of cash acquired. The Company paid $3.8 million to the sellers at closing, with the remaining $0.7 million payable to the sellers upon settlement of certain indemnities within two years of closing, ATS GREASEwatch develops, manufactures and markets remote tank monitoring devices, alarms, software and services for various applications and provides technology to enhance and expand our current product offerings.
The acquisitions have been accounted for as business combinations and were recorded by allocating the purchase prices to the fair value of assets acquired and liabilities assumed at the acquisition dates. The excess of the purchase price over the fair value assigned to the assets acquired and liabilities assumed was recorded as goodwill. The purchase price allocations associated with these acquisitions resulted in tax deductible goodwill of $7.5 million, customer relationship intangibles assets of $1.6 million, trade working capital of $9.0 million and $(1.1) million of other net liabilities. During the twelve months ended December 31, 2022, the purchase price allocations for Wade were adjusted, resulting in $1.3 million decrease to goodwill, primarily related to the aforementioned cash payment received from the sellers of Wade.
The Company's results of operations include the acquired operations subsequent to the acquisition dates. Pro-forma results of operations and certain other U.S. GAAP disclosures related to these acquisitions have not been presented because the acquisitions did not significantly impact the Company's consolidated statements of operations or financial position.
Nine-Month Transition Period Ended December 31, 2020
On December 11, 2020, the Company acquired substantially all of the assets of Hadrian Manufacturing Inc. and 100% of the stock of Hadrian Inc. (collectively "Hadrian") for a cash purchase price of $101.3 million, excluding transaction costs and net of cash acquired. During the year ended December 31, 2021, the Company received a $0.4 million cash payment from the sellers in connection with finalizing the acquisition date trade working capital, which is included in the total cash purchase price above. Hadrian, based in Burlington, Ontario, Canada, manufactures washroom partitions and lockers primarily used in institutional and commercial end markets and complements the Company's existing product portfolio.
The acquisition has been accounted for as a business combination and was recorded by allocating the preliminary purchase price to the fair value of assets acquired and liabilities assumed at the acquisition date. The excess of the purchase price over the fair value assigned to the assets acquired and liabilities assumed was recorded as goodwill. The purchase price allocations associated with the acquisition resulted in goodwill of $43.0 million ($36.9 million tax deductible), other intangible assets of $32.4 million (including tradenames of $0.8 million and $31.6 million of customer relationships), $17.1 million of fixed assets, $9.7 million of trade working capital and other net liabilities of $0.9 million. The purchase price allocations for Hadrian were adjusted during the year ended December 31, 2021, resulting in $0.3 million increase in goodwill related to final working capital adjustments and the refinement of the estimated fair value of the liabilities assumed.
The Company's results of operations include the acquired operations subsequent to the acquisition date. Pro-forma results of operations and certain other U.S. GAAP disclosures related to the acquisition have not been presented because they are not significant to the Company's consolidated statements of operations or financial position.
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4. Discontinued Operations
During the year ended December 31, 2021, the Company completed the Spin-Off Transaction of PMC. The operating results of PMC are reported as discontinued operations in the consolidated statements of operations for all periods presented, as the Spin-Off Transaction of PMC represented a strategic shift that had a major impact on operations and financial results. The consolidated statements of cash flows for the year ended December 31, 2022, the year ended December 31, 2021, the nine-month Transition Period ended December 31, 2020 have not been adjusted to separately disclose cash flows related to the discontinued operations. During the year ended December 31, 2022, the Company received $35.0 million from Regal Rexnord Corporation as a result of the final working capital and cash balances at closing exceeding the targets stipulated in the Spin-Off Transaction agreement.
In connection with the Spin-Off Transaction, the Company incurred approximately $60 million in separation costs during the year ended December 31, 2021, which are included within earnings from discontinued operations, net of income taxes in the accompanying consolidated statements of operations. These costs primarily related to professional fees associated with planning the Spin-Off Transaction, as well as Spin-Off Transaction activities within finance, tax, legal and information system functions and certain investment banking fees incurred upon completion of the Spin-Off Transaction.
The major components of the Income from discontinued operations, net of tax presented in the consolidated statements of operations during the year ended December 31, 2022, the year ended December 31, 2021, and the nine-month Transition Period ended December 31, 2020 are included in the table below (in millions):
Year Ended Nine-Month Transition Period Ended
Selling, general and administrative expenses/(income) (2.9) 260.2 168.0
Restructuring and other similar charges — 1.9 12.9
Amortization of intangible assets — 9.9 10.1
Interest expense, net — 4.1 3.3
Actuarial loss on pension and postretirement benefit obligations — 4.8 1.3
Other non-operating income, net — (5.6) (6.4)
Income from discontinued operations before income tax 2.9 99.1 109.2
Income tax benefit (provision) 1.8 (28.0) (25.8)
Equity method investment income — 0.3 0.2
Non-controlling interest income — (0.2) (0.4)
Income from discontinued operations, net of tax $ 4.7 $ 71.2 $ 83.2
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(1)Results of operations for the year ended December 31, 2022 includes the reversal of certain accruals as a result of costs the Company is obligated to indemnify Regal Rexnord Corporation for being lower than original estimates.
(2)Results of operations during the year ended December 31, 2021 reflect the period from January 1, 2021 through October 4, 2021, the date on which the Spin-Off Transaction of PMC was completed.
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The consolidated statements of cash flows for the prior periods presented have not been adjusted to separately disclose cash flows related to discontinued operations. However, the significant investing and financing cash flows and other significant non-cash operating items associated with the discontinued operations were as follows (in millions):
Year Ended Nine-Month Transition Period Ended
Amortization of intangible assets — 9.9 10.1
Gain on disposition of assets — (10.1) (1.3)
Deferred income taxes — 0.5 (3.8)
Actuarial loss on pension and postretirement benefit obligations — 4.8 1.3
Other non-cash (income) expenses — (0.3) 1.4
Stock-based compensation — 13.9 13.7
Expenditures for property, plant and equipment — (17.5) (23.5)
Acquisitions, net of cash acquired — — (0.3)
Proceeds from dispositions of long-lived assets — 14.3 7.2
Net payments from divestiture of discontinued operations 35.0 4.2 —
Repayments of debt — (1.6) (5.4)
Proceeds from exercise of stock options — 12.8 9.5
Taxes withheld and paid on employees' shared-based payment awards — (0.5) (0.4)
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(1)Results of operations during the year ended December 31, 2021 reflect the period from January 1, 2021 through October 4, 2021, the date on which the Spin-Off Transaction of PMC was completed.
During the year ended March 31, 2019, the Company completed the sale of the VAG business, which was previously included within the Water Management platform. The terms of the sale agreement provided the Company to receive contingent consideration, based on, and subject to, the VAG business attainment of Earn-out EBITDA, as defined in the sale agreement. During the year ended December 31, 2021, the Company received a $4.2 million cash payment as a result of the VAG businesses performance in its fiscal year ending March 31, 2021, which represented the final period of the earn-out, and was recorded within income from discontinued operations, net of tax in its consolidated statements of operations.
5. Restructuring and Other Similar Charges
During the year ended December 31, 2022, the Company continued to execute various restructuring actions. These initiatives were implemented to drive efficiencies and reduce operating costs while also modifying the Company's footprint to reflect changes in the markets it serves, the impact of acquisitions, including Elkay, on the Company's overall manufacturing capacity and the refinement of its overall product portfolio. These restructuring actions primarily resulted in workforce reductions, lease termination costs and other facility rationalization costs. Management expects to continue executing similar initiatives to optimize its operating margin and manufacturing footprint. As such, the Company expects further expenses related to workforce reductions, potential impairment or accelerated depreciation of assets, lease termination costs and other facility rationalization costs. The Company's restructuring plans are preliminary and the full extent of related expenses are not yet estimable.
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The following table summarizes the Company's restructuring and other similar costs incurred during the year ended December 31, 2022, the year ended December 31, 2021, and the nine-month Transition Period ended December 31, 2020 (in millions):
Year Ended Nine-Month Transition Period Ended
Employee termination benefits $ 13.6 $ 3.7 $ 1.8
Contract termination and other associated costs 1.8 — (0.1)
Total restructuring and other similar costs $ 15.4 $ 3.7 $ 1.7
Employee termination benefits $ 30.4
Contract termination and other associated costs 9.1
Total restructuring and other similar costs $ 39.5
The following table summarizes the activity in the Company's accrual for restructuring and other similar costs for the years ended December 31, 2022 and 2021 (in millions):
Accrued restructuring costs, December 31, 2020 (1) $ 0.5 $ — $ 0.5
Cash payments (1.8) — (1.8)
Accrued restructuring costs, December 31, 2021 (1) $ 2.4 $ — $ 2.4
Elkay opening balance sheet accrual 4.7 — 4.7
Accrued restructuring costs, December 31, 2022 (1) $ 7.8 $ 1.2 $ 9.0
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(1) As of December 31, 2022, $8.4 million of the restructuring accrual is included in other current liabilities and $0.6 million is included in other liabilities in the consolidated balance sheets. As of December 31, 2021, the restructuring accrual is included in other current liabilities in the consolidated balance sheets.
6. Revenue Recognition
A performance obligation is a promise in a contract to transfer a distinct good or service to the customer and is the unit of account in ASC 606. A contract’s transaction price is allocated to each distinct performance obligation and revenue is recognized when obligations under the terms of a contract with the customer are satisfied. For the majority of the Company's product sales, revenue is recognized at a point-in-time when control of the product is transferred to the customer, which generally occurs when the product is shipped from the Company's manufacturing facility to the customer. When contracts include multiple products to be delivered to the customer, generally each product is separately priced and is determined to be distinct within the context of the contract. Other than a standard assurance-type warranty that the product will conform to agreed-upon specifications, there are generally no other significant post-shipment obligations. The expected costs associated with standard warranties continues to be recognized as an expense when the products are sold.
When the contract provides the customer the right to return eligible products or when the customer is part of a sales rebate program, the Company reduces revenue at the point of sale using current facts and historical experience by using an estimate for expected product returns and rebates associated with the transaction. The Company adjusts these estimates at the earlier of when the most likely amount of consideration that is expected to be received changes or when the consideration becomes fixed. Accordingly, an increase or decrease to revenue is recognized at that time.
Sales and other taxes collected concurrent with revenue-producing activities are excluded from revenue. The Company has elected to recognize the cost for freight and shipping when control of products has transferred to the customer as a component of cost of sales in the consolidated statements of operations. The Company classifies shipping and handling fees
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billed to customers as net sales and the corresponding costs are classified as cost of sales in the consolidated statements of operations.
Revenue by Category
The Company designs, procures, manufactures, and markets a comprehensive portfolio of water management solutions. The Company disaggregates its sales by customer type and geographic location, which the Company believes best depicts how the nature, amount, timing and uncertainty of its revenue and cash flows may be impacted differently by certain economic factors. The following tables present revenue disaggregated by customer type and the geographic region of the end customer (in millions):
Year Ended Nine-Month Transition Period Ended
Year Ended Nine-Month Transition Period Ended
Contract Balances
For substantially all of the Company's product sales, the customer is billed 100% of the contract value when the product ships and payment is generally due 30 days from shipment. Certain contracts include longer payment periods; however, the Company has elected to utilize the practical expedient in which the Company will only recognize a financing component to the sale if payment is due more than one year from the date of shipment.
Billings are recorded as accounts receivable when an unconditional right to the contractual consideration exists. Contract assets arise when the Company performs by transferring goods or services to a customer before the customer pays consideration, or before the customer’s payment is due. A contract liability exists when the Company has received consideration or the amount is due from the customer in advance of revenue recognition. Contract liabilities and contract assets as of December 31, 2022 and December 31, 2021 were not material.
Backlog
The Company had backlog of $42.1 million and $69.9 million as of December 31, 2022, and December 31, 2021, respectively, which represents the most likely amount of consideration expected to be received in satisfying the remaining backlog under open contracts. The Company utilizes the optional exemption provided by ASC 606-10-50-14A for variable consideration, and has not included estimated rebates in the amount of unsatisfied performance obligations. The Company expects to recognize approximately 100% of the backlog as revenue in the year ending December 31, 2023.
Timing of Performance Obligations Satisfied at a Point in Time
The Company determined that the customer is able to control the product when it is delivered to them; thus, depending on the shipping terms, control will transfer at different points between the Company's manufacturing facility or warehouse and the customer’s location. The Company considers control to have transferred upon shipment or delivery because the Company has a present right to payment at that time, the customer has legal title to the asset, the Company has transferred physical possession of the asset and the customer has significant risks and rewards of ownership of the asset.
Variable Consideration
The Company provides volume-based rebates and the right to return product to certain customers, which are accrued for based on current facts and historical experience. Rebates are paid either on an annual or quarterly basis. There are no other significant variable consideration elements included in the Company's contracts with customers.
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Contract Costs
The Company has elected to expense contract costs as incurred if the amortization period is expected to be one year or less. If the amortization period of these costs is expected to be greater than one year, the costs would be subject to capitalization. As of December 31, 2022 and December 31, 2021, the contract assets capitalized are not significant. During the year ended December 31, 2022, the year ended December 31, 2021, and the nine-month Transition Period ended December 31, 2020, contract asset amortization was not significant and no impairment losses were recognized.
7. Inventories
The major classes of inventories are summarized as follows (in millions):
Inventories at First-in, First-Out ("FIFO") cost 380.7 188.8